5. Conclusion
This paper analyses the role played by independent audit committees in improving the credibility of earnings announcements in different institutional settings and, therefore, in affecting the reaction of financial markets. In a large sample of public companies in Western Europe for the period 2006–2014, we find that the independence of audit committees (measured with the percentage of independent members sitting on the audit committee) plays a key role in explaining the market reaction to earnings announcements. More importantly, when differentiating between firms in countries with strong or weak institutions based on the Brown et al. (2014) or the World Bank Group indices, we find that this relation only holds in countries with weak institutions (i.e. in countries where institutions do not favor greater credibility of earnings). This finding supports the idea that the independence of audit committees acts as a substitute for weak institutions to improve the credibility of earnings announcements. In addition, we show that fully independent audit committees especially affect the market’s reaction in countries with weak institutional settings. However, we acknowledge that relying on the companies’ classification of independence is a limitation of our study. It is likely that there are some errors in this classification. In particular, some firms may classify some non-independent members as independent members. Thus, in future studies, it would be interesting to see if our results are affected by other measures of independence. Furthermore, the Brown et al. (2014) index which we use to capture the strength of the institutional environment is also subject to limitations. This index is computed in 2008 and therefore may not reflect institutional changes in the later years of our sample period. Therefore we tested the robustness of our results by using an alternative, annually updated index provided by the World Bank Group. We find that our results still hold.
